Credit departments manage billions of dollars of capital and provide a system of checks and balances on company risk, but are chronically under funded and lack regulatory support to provide proper oversight. In the rush to make a quick buck, organizations often fail to invest the time and energy they should to constantly re-evaluate the strength of their policies and procedures and ultimately conduct business in a way that ensures long-term prudence and prosperity. Even with recent financial reform regulatory actions under the Dodd-Frank act, no person, department or governmental compliance effort can totally prevent all errors, misrepresentations, or deceptions. It is essential that organizations have their own enterprise credit risk management policies in place to provide transparency and to help ensure compliance. This market perspective presents a number of timely approaches for potential improvements to the regulation and administration of credit risk management issues.
Automated Collateralization / Margining
The International Swaps and Derivatives Association, Inc. (ISDA) recently conducted its 2010 ISDA Margin Survey. Over the last ten years, the number of executed collateral agreements has grown from 12,000 to over 170,000, with the estimated amount of collateral in circulation growing from $200 billion to over $3.2 trillion, and 83% are bilateral. Much of the tracking and application of collateral (and its expiration) is still conducted in spreadsheets, with the potential for manual error and/or incorrect calculation. This can lead to the belief that credit reserves are adequate when they’re not, or increased trading that is not supported by accurate and enforceable risk-mitigation provisions. Automation and audit-ability of the recording, maintenance, and calculation of collateral and margining is critical to meet the growing demand. Under Dodd-Frank, evolving requirements for minimums, timeliness, and collateral type will likely increase. Investments in this area support the business and help to avoid the next company going down because it couldn’t meet liquidity demands.
Credit Rating Agency Independence
Similar to auditing, paying a company to review your own business and provide a rating can represent a potential conflict of interest. And yet, critical decisions on billions of dollars of investments and contingent collateral requirements are based on those same ratings. If you look to the consumer sector, where credit bureaus like TransUnion, Equifax, and Experian provide FICO credit scores, revenue comes from the requestor of the score—individuals do not pay for their own evaluation. Even with the 2006 Credit Rating Agency Reform Act and the SEC implementation in 2007 of the Oversight of Credit Rating Agencies Registered as Nationally Recognized Statistical Rating Organization, NRSRO’s still rely on an “issuer-pays” business model. These ratings are too important to take a chance-- a subscription-based model would provide significant independence. Recent reforms mandated by the Dodd-Frank act (Title IX, Subtitle C) look to address the oversight and regulation of rating agencies, but it is still unclear how far and deep the changes will go. Market leading organizations will pay close attention and provide comments to the rule making process to ensure reform delivers comprehensive, sustained results.
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